Qantas tie-up is bad for tourism

Date: November 29 2012

Tony Webber

The tie-up between Qantas and Emirates may be good for Qantas but it is unambiguously bad for tourism.

Qantas decided to team up with Emirates because it could not achieve its targeted returns on international routes in which it competes head-to-head with Emirates, including London Heathrow, Frankfurt and the Tasman.

And it's not my view on Qantas' product vis-a-vis competitors – it's the view of well known airline surveys. I actually believe that Qantas' product is brilliant, but my view is shaped by the fact that I have flown at the front of Qantas planes many times, I have worked for the airline for years and would easily work for them again.

Qantas has no direct control over the seats brought into the market by competitors, the global price of oil, the state of the global economy and asset prices, its geographical hub location and the fact that air rights are negotiated bilaterally between Governments. It can optimally respond to these forces, which is where I think it can do better, but these optimal responses only reduce their impact they don't stop it.

Qantas also has little choice but to charge a higher price than competitors, even though competitors may have a superior product, because its unit costs are higher. If Qantas wants to remain Australian then it is faced with significantly higher labour costs and tax liabilities. No productivity improvements or cost transformation programmes in the world can bridge the unit cost gap.

Faced with excess supply, low yields, high costs and limited ability to compete against top quality opposition, Qantas' international earnings have suffered. This has restricted its ability to pump more money into product improvement which, circularly, has further weakened its ability to compete with class opposition.

The tie-up with Emirates takes out a very intimidating head-to-head competitor and provides Qantas the opportunity to transform an adverse exposure to Emirates unrelenting capacity growth to a favourable exposure.

Geoff Dixon clearly doesn't agree with this. My guess is for the following reasons. The first is that Qantas has been very outspoken in the past about Emirates and the subsidies it allegedly enjoys. By now declaring unconditional love and admiration for Emirates the long term messaging is clearly confusing.

Secondly, it's bad for tourism. The world without the arrangement between Qantas and Emirates will have fewer international seats than the world with it. Fewer seats means fewer passengers, including inbound tourists. While Qantas will divert some capacity from Europe to Asia as a result of the tie-up, the net impact will be fewer seats entering and leaving the Australian market.

Thirdly, the tie-up is risky for a number of reasons. Australians and Europeans have a love affair with stopovers in Asia, with around 50 per cent of passengers travelling between Australia and Europe enjoying a stopover. The Australia to Dubai sector is much longer than to Asia, therefore Dubai is not as effective as breaking up the journey to Europe.

Lastly, the large Jewish community in Australia and Europe may be apprehensive about travel via Dubai. And passengers that book on Qantas but fly on Emirates may sample the superior product for themselves and next time book directly on Emirates.

It's also clear that Dixon and Joyce don't see eye-to-eye on the value associated with selling off or floating key airline operating segments, such as the Frequent Flyer Program, Jetstar and to a lesser extent the freight business. Interestingly, they still appear to see eye-to-eye on the 65 per cent domestic market share strategy – not all of Dixon's strategies are apparently duds.

Much of the impetus for the current agitation by Dixon and his mates boils down to the current price of Qantas stock. Trading at $1.32 this afternoon, the stock looks cheap by historical standards, but is it?

Qantas appears to take the view that its balance sheet and future earnings trajectory should have the stock valued much higher. I agree. But the stock's valuation is not determined objectively on the basis of this information.

It is determined on the basis of how investors and analysts translate this information into a stock price. On the basis of my modelling of the historical performance of the stock over the past seven years, which implicitly includes investor views, the value of the stock is currently worth just $1.45.

Can Dixon and his mates transform the international segment of the business so that it more consistently achieves target returns? The short answer is no – but no one can. I have a significant amount of respect for the CEO of Qantas international, Simon Hickey, but I don't think he can either. The forces that are beyond the control of Qantas are just too great and unpredictable. It is for this very reason that 50 per cent of air capacity into and out of Australia is wholly or partly government owned.

Tony Webber was Qantas Group chief economist between 2004 and 2011. He is now managing director of Webber Quantitative Consulting and Associate Professor at the University of Sydney Business School.

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